International Monetary Fund says we're doing well but watch tax risks and opportunities

They (the IMF) came, they saw, they talked tax and they issued their press release recently. They spoke of the external risks of Brexit, US and EU tax proposals or as I call them “BUE”.

There was good news in that in their view the medium-term outlook remains positive, growth is robust and broad based and unemployment is at levels “not seen in almost a decade”. However (isn’t there always a “however”) they said “the challenge” is to translate this into a “new foundation for sustainable and inclusive growth”. So watch the BUE.

The IMF regards Brexit as the “most pressing and far-reaching challenge” for us. The press release didn’t go much further than that but you can see their point given the already slowing in export growth to the UK according to Enterprise Ireland’s recent numbers. Much has been said and written on the possibility of tariffs being imposed on trade with the UK. But what about business within Ireland itself?

For example, say you have a group of Irish companies with a UK resident parent company all going about their business. Provided tax law conditions are met (e.g. the relevant group companies are EU resident) then the Irish group companies can transfer assets among themselves without Capital Gains Tax applying. The tax doesn’t kick in until, for example, the company holding the acquired asset (the host) leaves the group with the asset. I call this the “Kane effect” after John Hurt’s character in the movie “Alien”.

On leaving the group the deferred capital gain bursts out and becomes taxable. Until then it sits dormant in the host company like the extra-terrestrial in Mr Hurt’s “host”. When the UK leaves the EU then this tax group is broken bringing about an instant “Kane effect”. Transferring assets between group companies is not infrequent so this may require legislative amendment. We have time but it, like other tax law, may require fixing to avoid a “Kane effect” for taxpayer companies when Brexit happens.

The press release notes that discussion of reforms in the US and the EU contribute to uncertainty given the “sizeable role of multinationals in the economy”. This increases the need for a broad base and “continuing efforts to reinforce the dynamism of the domestic economy”. Taking each in turn and starting Stateside:

President Trump wants to reduce the corporate tax rate to 15% and introduce a tax rate reduction for the repatriation of earnings. Commenting after our recent International tax event, my partner Joan O’Connor noted that future investment in the US pharma and medtech sectors here could be put on hold as a result. However, the IT sector might not be under the same threat from such reform as that industry runs significant auxiliary services which requires multiple locations.

The Border Adjustment Tax (BAT) was not mentioned specifically by the IMF (or indeed in President Trump’s tax plan) but it was part of the previous debates. It would have a negative effect on our US exports given that it would deny US deductions for them making them more costly there. Many argue it won’t see the light of day and the US retail sector continues to lobby against it.

No specific EU proposals were mentioned by the IMF. However you’d have to think that they were getting at the Common Consolidated Corporate Tax base (CCCTB). This effectively takes profits from each member country and allocates them around Europe for tax purposes based on sales by destination, assets and employees by location. Even without the second ‘C’ this would be detrimental to our economy and tax regime for both FDI and indigenous industry operating across borders. This is because countries operate tax systems appropriate to their economies and as we know not all have the same needs.

IBEC have estimated a total cost per year of €4 billion. Denmark, Malta, the Netherlands, Sweden and the UK have said, like us, that the proposed regime is contrary to EU law and have told the Commission so. Given all of these negatives, as I’ve previously written, shouldn’t the EU Commission heed Disney’s counsel in the movie “Frozen” and “let it go”?

The absence of specifically identified proposals for the US and the EU must be contrasted with the IMF specifically mentioning our “Help-to-Buy” scheme. On housing the IMF refers to the mismatch between demand and the “lagged supply following the real estate bust” and welcomes the planned review of the Help-to-Buy scheme given it “may add to demand pressures”.

The IMF points out “Ensuring affordable housing is crucial for the well-being of the Irish population and important to economic competitiveness.” I’ve previously written in this newspaper that increasing rental supply of houses is a critical part of our economic competitiveness and that potential landlords seeking to acquire new properties for rental purposes could be disadvantaged by the scheme. The counterbalancing suggestion was to bring about an income tax credit for VAT incurred on property acquisitions. Maybe the IMF reads the Sunday Independent!

Regarding efforts to reinforce the domestic economy, the IMF suggests expansion of government support for SME driven R&D including direct funding measures. It’s well known that our R&D credit regime is up there with the best of them but like all things its practice could be improved and it’s hoped that the IMF’s suggestion could be acted upon.

Back in 2015 the Department of Finance initiated a public consultation on entrepreneurship and we suggested various measures at the time. These included financing arrangements whereby individuals could lend money to SMEs with the market rate interest received being taxed at the standard rate of income tax (20%) as opposed to the marginal rates which can be north of 50%. Such financing could provide additional indirect support for SME driven R&D. Perhaps the IMF recommendations here could fast track such endeavours.

The IMF suggest a review of tax expenditures and to prioritise the use of limited fiscal space. Therefore choices may have to be made at the Department of Finance regarding any tax suggestions. As the Grail knight said to Harrison Ford in one of the Indiana Jones movies “You must choose. But choose wisely” and Finance Act 2017 isn’t that far away.

Arguably, all of the above urges a form of healthy paranoia regarding BUE. Andrew Grove, former CEO of Intel wrote a book on management theory called “Only the Paranoid Survive”. I would concur given although the future appears somewhat bright but we don’t have to wear shades…yet.

Tom Maguire is a Tax Partner in Deloitte and his monthly columns on tax matters appear in the Sunday Independent. The above article was first published on 28 May 2017.

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